It's never been out of the question. In the years that they have been kicking the can down the road, all of the EU financial institutions have been preparing for this exact thing. You can expect Greece to exit the euro with little to no effect. The euro will of course rise, because the caliber of the remaining countries are much stronger.

The real issue is contagion. The EU doesn't want Italy or Spain to go down as well, because the markets/bond vigilantes love to pile on when there is blood in the water. Look at what happened during the Asian currency crisis, it was mass contagion throughout Asia that caused the subsequent problem.

That's also what, afaict, is keeping the problem from just being solved. Greece is small enough that it's quite possible to restructure their bonds into some workable package rather than kicking the can 6 months at a time. The IMF, for example, was floating a €50 billion debt haircut, which is not a ton of money in absolute terms. Alternate proposals would cap repayment in line with GDP, e.g. 1% of GDP per year, which would in effect amount to writing off a few tens of billion € per year (by letting it inflate away). But the EU is worried about setting a precedent that might impact a much bigger country with bigger debts, like Spain. (The other issue is just pure political constraints. Many EU countries currently have strong populist-right parties either in government or with an influential position in the government, like True Finns and Dansk Folkeparti. These parties are obviously against anything that looks like being "soft on Greece".)

IIRC, the effects of the late '90s Asian crisis didn't last this nearly this long though... The Greek tragedy/farce double feature has been going on for over five years now.

It's like Greece has been frozen into a creeping state of crisis. This can destroy an entire generation. A rapid shock might have been preferable all along.

Gp asked about default and you answered about abandoning the euro. The two issues are totally unrelated.

Greece could leave the euro and continue with debt or default on debt and keep the euro.

Leaving the euro would be nuts and bad for the country. Defaulting on the debt is probably necessary.

The EU has already said that the referendum is about staying or leaving the EU.

Leaving the euro would be the best thing for the country. You can't rehabilitate your economy if you don't have control over your own currency (dropping the exchange rate, encouraging and influx of foreign money, etc). Look at Iceland, only a few years after their banking crisis, they are thriving. ]

Some of this has to do with faulty investor logic. The euro was sold to investors in a way where they believed that once in the currecny there was no exit. So they tried to price all of the components the same, rather than pricing in soverign risk for each state. Or, in other words, if any investors pricied in sovereign risk others would be there to arb it out of the system.

I think for that there should be some mechanism to let the investors take the hit. The issue is whether or not the cost to bail out greece would be cheaper than to deal with the incremental risk premium on the rest of the eu debts. At some stage the tradeoff between economic logic and incentives (moral hazard) needs to be dealt with more transparently.

I don't know why just a default would be such a big deal, really. I can't remember ever really hearing any particularly convincing argument why a default must cause a grexit.

The reason for the original bailouts was to save the banking system. National governments took on their own banks' bad debt and the export countries lent money to the import ones. All bad debt, public and private, essentially ended up as inter-governmental debt. Whether the rest of the economy could somehow have been insulated from a banking crash at a lower cost than needed to bail out the banks is unclear. The way the banks were bailed out is, shall we say, less than uncontroversial.

Because other EU countries were in trouble, too. If Greece defaulted back then, investors would have lost their bounds and countries like Spain would have had big problems to sell their bounds.

It is much harder to consolidate your finances if you have to pay higher interests than already solid countries.

Before the Euro countries had a mechanism to tackle this: They could just print more of their own money. Italy was an example for that. They just weakened the Lira while Germany did not weaken its Deutsche Mark, so it was easier for Italy to export and harder to import goods.

The US entities that default do not have this problem, because there is always the state and federal governments that can step in after the default and help finance them. The Euro group did not had any entity that could help before the crisis. Now there are two mechanism ESM [0] and EFSM [1], but these two are essentially just fonds + some rules and can help only to a certain extent. They are too small to save a country like Italy or Spain if it defaults totally, let alone several of them. There is no entity above like the US federal government except the ECB itself, which does not have the mandate to do stuff like that (even if they do it anyway [2]).

Another reason is of course that state bonds are considered safe, so French and German insurance companies and the like invested in them, which would have needed to be bailed out later on anyway.

I think if Spain, Ireland etc. would not have saved their banks back then, it would have been safer to let Greece default. But we do not know what would have happened instead and it is always easier to say would should have been done afterwards.

[0]: https://en.wikipedia.org/wiki/European_Stability_Mechanism

[1]: https://en.wikipedia.org/wiki/European_Financial_Stabilisati...

[2]: http://www.forbes.com/sites/jonhartley/2014/10/14/legality-o...

Yes, they made foolish loans and it would be somewhat appropriate that they lose in this investment, however, the loans were made based on inflated Greek numbers (numbers which made the economy look stronger).

That said, reverting back to the drachma would probably be more fiscally painful to Greeks than the austerity alternative. It's a lose lose for both parties, so staying with the euro is desirable despite some of the bad medicine.

>In a reasonable world, the parties who loaned Greece all that money for ridiculously low interest rates in 2000-2007 should have suffered the losses.

well, until of course these parties have access to power...

>Why is it considered a huge threat to the euro

and this is how they PR-ed everybody into fear of default :)

Politics? Technicaly, they are already in default as they have missed payment to the IMF.